Dynamic portfolio plans on the comeback trail

MUMBAI: Structured portfolio schemes, based on a constant proportion portfolio insurance (CPPI) model, are back in vogue, after nearly two years. A CPPI portfolio is a quasi debt-equity structure that enables investors to rebalance their investments to either asset class (debt or equity) on the basis of market outlook.

With equity valuations beginning to look expensive, affluent investors are looking for safer avenues, even if it means lower returns.

While there are structured note offerings that promise capital protection and equity index-linked returns, it doesn't allow investors the flexibility to scale up investments on a 'favourable looking' asset class beyond a point.

CPPI portfolios allow a more dynamic asset allocation method, and restricts downsides (by assigning a stoploss on the underlying index) and ensures unlimited upside based on performance of the underlying portfolio. Benchmark AMC, ICICI Pru AMC and Kotak MF are among the top CPPI portfolio providers.

A CPPI portfolio is structured. Supposing investor 'A' wants to invest Rs 1 lakh in a CPPI portfolio. He doesn't really mind losing up to 10% of his portfolio in any market eventuality. In such case, Rs 10,000 is the cushion that the investor allows the fund managers and Rs 90,000 becomes the 'bond floor' or 'risk level'.

The fund manager then mathematically calculates a multiplier tag based on back-testing a similar portfolio. The tag could be a single number (generally) between 1 and 5.

The multiplier tag decides what portion of money needs to go into equities (or the riskier asset class). For instance, if the multiplier tag corresponding to 'A's risk appetite is 3, the fund manager allocates Rs 30,000 into equities (multiplier 'X' the cushion amount of Rs 10,000) and the remaining in debt.

Once the equity portion is allocated, the fund manager moves the money between shares and debt instruments, depending on where the indices are headed. The gains that the fund manager makes on equity portion is reinvested into the main corpus. The capital will be maintained by gains in the debt portion. CPPIs are structured in such a way that they can invest up to 100% investments in equity or debt.

"The basic idea of a CPPI is to shield capital from adverse market movements and at the same time, generating some returns on the portfolio. Investors, who are not confident of current market levels, are seeking CPPI structures," said a Benchmark AMC spokesperson.

According to Nilesh Shah, CIO, ICICI Prudential AMC, CPPI works more like an insurance policy. The cushion part acts as the premium, while the remaining portion is pure investment.

"Investors who had entered into CPPI structures in and around September 2008 would have made decent money, as they would have got full exposure of equity markets. However, CPPI would have underperformed pure equity mutual funds, because of the debt portion in the structure," Mr Shah added.

Detractors of CPPI opine that the strategy fails when the market opens with a high gap, up or down. The whole product is dependent on the expertise of the fund manager.

A wrong estimate of the market swing (volatility) could impact equity exposure of the structure. A section of wealth managers believes that the opportunity cost is high in CPPI structures, because of large debt exposure.